The real interest rate in the economy has turned negative, with inflation based on the Consumer Price Index (CPI) at a more than three-year high of 5.54% and the policy rate taking in pension at 5.15%. If this persists, it would be a drag on savings, when the interest rate on savings itself is falling.
However, this does not yet indicate a reason for despair. The rise in CPI inflation is mainly due to food prices, especially onion, which recently jumped to Rs 200 per kilogram, from the usual Rs 20 to 30 per kg.
With fresh crops expected to be harvested in January, prices are expected to drop, along with food inflation, from February. So what should matter is how core inflation – rising prices except for food and fuel – works. In this regard, core inflation has remained low in India.
Economists say it won’t be fair to say that interest rates have turned negative just because headline inflation has exceeded the key repo rate. What matters is the composition of inflation.
“Core inflation, which is between 3.2 and 3.5% (depending on the measure considered), indicates that real interest rates in India remain among the highest in the region,” said Abhishek Gupta, economist at Bloomberg.
“Unfortunately, the Reserve Bank of India (RBI) is focused on food inflation and its policy is driven by onion prices, in the short term. We think the RBI will now wait for inflation to peak before lowering rates, ”which could come in April, according to Gupta.
In response to a question about whether entering negative real interest rate territory prevented the RBI from further cutting rates in December, Gov. Shaktikanta Das said that was not a consideration.
“I will not go into the question of this real interest rate…. because monetary policy cannot have more than one objective. I also said that at the previous MPC press conference. The monetary policy committee cannot pursue more than one objective, ”Das said.
“The objective is price stability, that is to say inflation, bearing in mind the objective of growth. So naturally, when we adjust the key rate, we will have to keep in mind how far it can go, keeping inflation in mind, ”the governor said.
There are many reasons for not considering the real interest rate as something serious. “These are all technical terms, which are seen as substitutes for other things in the real world. For example, nominal gross domestic product is an approximation of business cash flow and the real interest rate is an indication of cash flow versus interest costs, ”said a senior economist at a bank.
Consumer behavior does not change when interest rates turn negative, economists say, but a persistent negative real interest rate affects the generation of internal returns for banks, which is happening in Europe.
The RBI is expected to cut its key rate to 4.5% during this rate cycle, economists say. Inflation is expected to decline to 4.0-3.8 percent in the first half of the year, according to the RBI forecast.